Advertisements

Difficult Times Sometimes Create Desperate People Who Do Desperate Things: Loss Prevention in Handling Client Escrow Funds


Atla Escrow

Image by Thomas Hawk via Flickr

Jerome Kowalski

Kowalski & Associates

January, 2012

My copy of the Model Code of Professional Responsibility runs to some 500 pages, with sundry commentaries.  The Code plumbs virtually aspect of a practicing law and details that which can be done by lawyers and that which may not. One relatively brief section deals with lawyers handling of client funds held in the law firm’s escrow account, sometimes called “Escrow Accounts,” “Special Accounts,” “Trust Accounts” or “IOLTA (Interest on Lawyers Trust Accounts – but this one is a long and irrelevant boring story).   Cut to the quick, the Model Rules say just three things:  (1) Don’t co-mingle these funds with any other account; (2) deal with these funds exactly as instructed by the client and affected parties, as detailed in an appropriate escrow agreement and (3) if you even think about screwing around with these rules, you’re gonna fry.

In New York City, the Departmental Disciplinary Committee, the judicial authority having authority over lawyers’ compliance with applicable rules, investigates thousands of complaints filed against lawyers for all sorts of alleged violations of the applicable rules.  Yet, perhaps 80% of all suspensions and disbarments result from either defalcations or co-mingling of client funds. Here, justice is swift and certain. The Committee has long had a zero tolerance policy with regard to any impropriety concerning client funds, a view held by all governing bodies. Suspension or disbarment is the only result.

These facts are well known to all practitioners and may even strike some as a hackneyed topic. But recent reports of significant defalcations by a former counsel at a BigLaw firm of what may be as much as $20,000,000 and in another instance of the chair of a global law firm’s Asian gaming group having allegedly slipped out some $2,000,000 from client escrow funds to allegedly cover his own gambling losses suggest that this topic requires  careful review.  Indeed in year-end reviews by several of our law firm clients, prompted by the recent tawdry headlines, controls over client escrow funds were studied and found to be lacking. There have also been a recent spate of unsubstantiated rumors concerning of escrow account improprieties that are, simply put, more than troubling.

Some law firms dispense with the entire issue by simply eschewing, as a general rule, the maintenance of any escrow accounts. Where funds are required to be escrowed, these firms advise the retention of an independent trust company, bank, title company or where permitted, a duly licensed escrow agent.  However, often, local custom and usage requires law firms to maintain escrow accounts, which are fraught with peril, if not subject to stringent controls by the law firm. These controls should be described in writing and the firm’s policies regarding client funds should be in writing and part of its employee  handbook.  These rules should also be part of every new lawyer’s orientation session as he or she arrives at the law firm.

The required controls begin with the commencement of the client relationship. Every engagement letter must contain a disclosure regarding the law firm’s escrow policies. The letter should describe the firm’s policies concerning escrowed funds and, particularly, the requirement that all funds released from escrow require two partner signatures. Funds released by wire transfer require a separate email confirmation from a law firm partner to the escrowee.  The engagement letter should require the client to report any departure from these rules to the firm’s managing partner. The need for the double signature and reporting is best demonstrated by the fact that in one of the recently reported instances of trust fund defalcation, a counsel of a national law firm is reported to have taken a check drawn payable to his law firm, as escrow agent, walked across the street and simply opened an account in the firm’s name, making himself the sole signatory, without the bank requiring any certification from any partner at the law firm.

The law firm should not allow the deposit of any escrow funds without an accompanying escrow agreement. Thus, the firm should have a tightly drafted model form of escrow agreement, with appropriate exculpatory language, from which there should be no material departure, except upon written consent from department head, an office head or an executive committee member.  Each such agreement should also require the signature of such a member of management. When funds are deposited in to the escrow agreement, the requested deposit should only be permitted to be made to the accounting department of the escrow agreement, the underlying agreement, stipulation or other instrument giving rise to the creation of the escrow, as well as a memo (or standard form) from the responsible lawyer describing underlying transaction and the conditions precedent for the ultimate release of the escrow. This initiating memo should also include the client’s contact information. The memo form should be countersigned by a member of management. A member of the accounting department should examine the entire submission for regularity and completeness.  Any departure from the firm’s escrow policies must be reported in writing by the escrow clerk to the responsible lawyer, as well as to a member of management (optimally, if the firm has an in-house general counsel, the mater should be addressed to him or her), even if the departure seems to be only clerical or ministerial.

When funds are mature and are required to be released, the responsible lawyer should prepare a new memo (or standard form), describing the transaction should be prepared by the responsible lawyer and countersigned by two partners with management responsibilities, such as an office head, department chair or member of the executive committee. The submission should again include the underlying escrow agreement and governing instrument. Again, the escrow clerk should examine the entire submission for completeness and be obligated to report in writing any irregularities to each of the lawyers who have already put their fingerprints on the escrow arrangement as well as general counsel or a designated separate member of management. As I mentioned above, all checks drawn on the escrow account should require the signature of two partners, neither one of which is directly involved with the matter.  If a wire transfer is required, the clerk should send a confirmatory email to the client, using the email address originally provided at the time of the original submission.

Where law firms sometimes screw up is in connection with smaller branch offices, at which smaller support staffs and reduced lawyer headcounts often breeds shortcuts, for the sake of expediency. The fact is that far greater scrutiny is essential for smaller branch offices, which often takes on a degree of laxness and informality, primarily because of the greater sense of intimacy such smaller offices promote. In the age of the Internet, emails and paperless offices, there is no excuse for departing from the required controls. There simply must be zero tolerance for any departure from these controls. After all, bar associations and other governing bodies have none.

The law firm’s general counsel, chief financial officer and its chief risk manager should be responsible for regularly monitoring activities in the firm’s escrow accounts and its escrow clerical staff. As much as law firms are allergic to certified financial audits, the law firm’s outside accounting firm should be required to annually audit its escrow funds and provide written certification that all controls are in place and there is full compliance with the firm’s stated policies.

Finally, as too few lawyers realize, defalcations from escrow funds are not covered by a law firm’s malpractice policies. A separate fiduciary policy is required. Insurance carriers tend to be rather chintzy on these policies, often limiting coverage to $5,000,000. That may be far too low, if your firm’s escrow balances or individual escrow accounts exceed that amount.  You should explore increased coverage or excess coverage with your insurance adviser. And, finally, always be prepared for the public relations hailstorm that will assuredly ensue if you are indeed the victim of a nefarious lawyer with your firm.

© Jerome Kowalski, January, 2012. All Rights reserved.

Jerry Kowalski is the founder of Kowalski & Associates, a consulting firm serving the legal profession exclusively. Jerry is a regular contributor to a variety of publications and is a frequent (always engaging and often humorous) speaker to a variety of forums. Jerry can be reached at jkowalski@kowalskiassociates.com or at 212 832 9070, Extension 310.

Advertisements

Essential Elements for Interviewing a Law Firm Lateral Candidate


English: One_Over Interviewing

Image via Wikipedia

 

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             December, 2011

 

About thirty years ago, I was assigned to be a second seat on a complex multi-party securities fraud case.  Among the many lawyers working with us on the defense side was a partner (let’s call him Tom here) at an AmLaw 50, who was a widely respected litigator with 25 years of experience. In fact, shortly before the case was scheduled for trial, this lawyer was nominated to serve as a judge on the United States District Court for the Southern District Court.  A month or so before the case was scheduled for trial, the lawyers for the dozen or so defendants met to begin planning for the trial and dividing up the various pretrial and trial tasks.

As the meeting started, Tom looked around the room and said plaintively “fellas you got to help me out here. I’ve never tried a case before. I’ve got lots of deposition and motion experience and some evidentiary trial experience in connection with injunctions, but I’ve never even seen a jury trial”  Yes, we all stared in disbelief. Five or six of the seasoned trial lawyers in the group took Tom aside and gave him a four day crash course on jury trials.

The case was duly called for trial and in the six weeks of trial, Tom, who had a high degree of innate intelligence, acquitted himself well, although I can’t say the same about his client who was found liable for serious damages. A few weeks later Tom’s nomination was confirmed. He attended judge’s school, went on to serve with distinction and ultimately became chief judge of the district.

The story comes to mind in connection with an interesting and provocative article by Mark Herrmann of Above the Law in which he discusses different interviewing techniques for lawyers being considered as lateral candidates at law firms. Herrmann first discusses the two standard techniques, resume based interviewing and second, behavioral based interviewing. The former is straightforward and is one in which the interviewee is asked about items on his resume. The second involves asking candidates about experiences in their lives and how they handled them.

The issue is even more timely, following a recent piece by Professor Steve Harper entitled “Fed to Death” in which Harper recounts, among other things, that injudicious lateral hiring of partners has caused the implosions of many major law firms.

A correspondent to Herrmann, Alessandro Presti suggested to Herrmann an entirely different approach. As recited by Herrmann, Presti

 “… suggested giving an applicant a relatively non-technical contract and asking the applicant to interpret it or identify issues that the contract left open. This might give insights into the applicant’s ability to identify issues and analyze them. Once the applicant identified the issues, you could explain that your client wants to launch a new product and ask whether the contract permits this. This would force the applicant to synthesize information and present it, thus demonstrating communications skills.”

While not utilized often, I have in the past fact seen this approach taken.

A couple of years ago, I arrived at the office of a managing partner of an AmLaw 200 firm for a scheduled meeting. He greeted me in the reception area and asked me to excuse him for a moment or two, since he had to conduct an interview of senior real estate associate who was being considered by the firm.

I was initially annoyed, thinking that I would have to cool my heels for 30 or 40 minutes as he conducted the interview.  Instead, he returned and collected me within five minutes. I complemented him on his efficiency in conducting such a quick interview. He explained that he simply started the interview and would conclude it in an hour. He went on to explain that he gave the associate a term sheet for a lease and a draft lease and advised her he would be back in an hour, at which time, she should mark up the lease and he would then discuss her markups when he returned. This was a first for me and I complemented him. He said that he’s been using this technique for a six months. He invited me to join him when he went through the second  substantive part of the interview.

We came in to the conference room and saw a clearly flustered lawyer on the telephone shouting at her headhunter.

She then sat across the table from the MP and slid her markup across the table. The MP began asking her questions about her comments in a mixed style of a partner reviewing an associate’s work and an adversary conducting a negotiation. When he got to the third page, he asked her about an issue that she missed entirely. She was silent for a moment and then tried to
explain that she just wasn’t given enough time to do a thorough review. He said, “you know, here, we are always working under time pressures.” She burst into tears, collected her things
and left. He turned to me and said, “too bad, she’s not going to work out here. Her legal work was pretty good but if she thinks this was pressure, wait until she has to deal with an SOB client or adversary.”

As we approach what will surely be a busy recruiting season, particularly at the partner level, we owe a debt of gratitude to Herrmann for opening up this subject for careful consideration. Much has been written about the essential need for due diligence, not enough has been addressed concerning testing the technical skills of lateral candidates.

Years ago, a fast growing law firm recruited a litigator who had an outsized ego and boasted an enormous book of business.  Once on board, he pitched none other than Donald Trump to handle a significant case.  He neglected to mention to The Donald or his partners that his only jury trial experience was a one day minor Civil Court case. Unlike Tom, he did not have a table full of experienced trial lawyers to guide him along and his hubris precluded him from confessing to his partners that he lacked real trial experience or from asking his experienced partners for a helping hand. He also assuredly did not want to share any “responsible partner credit”  with anyone. The case went to trial and received an inordinate amount of publicity.  The result was embarrassing; The plaintiff prevailed but the jury awarded damages of $1.00, which the court duly trebled.  The tabloids had a field day with this. This lawyer did conduct second jury trial several years later. In that second trial, he appeared pro se, defending himself of defrauding clients of millions of dollars.  This second time, he didn’t fare as well and his subsequent time in prison may have tempered some of his hubris.

So what do you ask a lateral candidate?  I would suggest a combination of resume, behavioral and real life discussion.

Review with a litigator some of the cases he’s worked on.  Pick up the identity of those cases from a Google search, if he or she hasn’t given you a list of cases he or she has worked on. Ask for the details that went on in strategizing the case, why certain motions were made or not and how the case was staffed, including the precise role played by the candidate.

Then pick up a recent case that landed on your desk and ask the candidate about his or her reactions to the claim (of course, being careful not to divulge client confidences).  Challenge him or her on some of some of the theories advanced. Inquire about how he or she envisioned litigating the case.

Ask about some of the adversaries he or she has dealt with.  Telephone one or more that you or your partners may know and mention casually that you ran into the candidate and ask about his or her skills and demeanor, being sure to couch the conversation as being prompted by idyll curiosity.

Ask transactional lawyers the same types of questions.  Inquire about deals worked on in the past.  Describe a pending deal (hypothetical or not) and ask how he or she would structure the deal.

A very similar approach should be taken with regulatory lawyers.

I know all of this sounds a bit gruesome and perhaps overbearing. But, if you are doing things right, your lateral partner questionnaire is overbearing and the ubiquitous use of these questionnaires have made them simply part of the pain a lateral must bear in making the move.

Explain at the outset, either directly or through your headhunter, that part of your firm’s recruiting process entails these procedures, so that there are no surprises.

Steve Harper is right in that lateral hiring may be fatal when not done well. Every managing partner can recite instances in which a lateral was a disappointment. And every managing partner knows full well that taking on a lateral involves substantial risk and investment. That risk must be managed carefully and tempered by a careful and thorough detailed vetting of the candidate. The future well being of your firm rests on working through this process with great care, vigilance and diligence.

© Jerome Kowalski, December, 2011.  All Rights Reserved.

 Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at jkowalski@kowalskiassociates.com .

 

I Know You Hate Keeping Time Sheets, but Even in the New Era You Must Still Do So and Here’s Why


Taxi meter

Image via Wikipedia

                                                                                      Jerome Kowalski

                                                                                      Kowalski & Associates

                                                                                      December, 2012

 

Some time ago, I wrote that even in the era of alternative fee arrangements and value billing, it remained essential for lawyers to record time.  I’ve been asked to revisit the issue and still come to the same conclusion, perhaps even more forcibly. There are myriad reasons that compel this conclusion.

First, despite the continued proliferation of AFA’s and value billing arrangements, the American Bar Association Model Rules of Professional Responsibility does not specifically permit for pure value billing.   Accordingly, well informed lawyers must be exceedingly careful in drafting their AFA agreements so as to meet the Model Rules.  But, even in a carefully drafted AFA, with both parties negotiating in good faith, some courts have continued to hold that fixed fees are unethical and unenforceable, requiring a plaintiff law firm suing a client to prove the value of its services based on the hours actually billed.

Sure, as others observed the old model of the client getting in your cab and all that you were concerned with was that the meter is running, but the taxi driver didn’t really care where you’re going no longer applies. In the old days, it was just about getting your fare. Today, you need to be far more concerned about where your client is going, but you need to keep that meter  ticking away for a variety of reasons, not all of which relates to collecting your fare at the end of the ride.

Just yesterday, the Delaware Chancery Court, in a derivative case in which plaintiffs’ counsel obtained a judgment of some $375,000,000,000, the court awarded plaintiffs’ counsel total fees of $285,000,000 (no, those are not typos).  The fee award came to a staggering $35,000 an hour.  Defense counsel argued for fees of less than $14,000,000.  Clearly, the battleground was neither the plaintiffs’ counsel’s customary and hourly fees nor the amount of hours billed to the case.  But, in order for these plaintiffs to celebrate a huge payday, they were required to submit a written application, which included details of its hourly billing, Similar rules exist in every bankruptcy court in the nation, which approves every fee application for every professional, save for those rare instances for which the court previously approved either a fixed or contingent fee.

In a case decided just last May, noted New York attorney Thomas Puccio successfully prosecuted a class action on behalf of New York City police entitled Scott v City of New York officers and thereafter filed a fee application for some $2,000,000, based on reconstructed time records. Puccio’s award was knocked down to $515,000,  The reason:  Puccio and his colleagues did not keep detailed contemporaneous time in derogation of Second Circuit rules which provide:

 “All applications for attorney’s fees, whether submitted by profit-making or non-profit lawyers, for any work done after the date of this opinion should normally be disallowed unless accompanied by contemporaneous time records indicating, for each attorney, the date, the hours expended, and the nature of the work done.”

As one commentator on this case observed:

“This issue arises because the lawyer for New York City police officers, who successfully sued New York City for overtime violations, sought over $2 million in attorneys’ fees. He submitted a 96-page attachment to the fee motion reflecting more than 2,000 hours of work. But these were not contemporaneous records. The lawyer acknowledged that “the entries were prepared instead ‘by my office working with outside paralegal assistance under my general supervision'” and that “the paralegals based the entries on ‘an extensive database of incoming emails maintain by my law firm in a computer folder.'” In other words, the time records in support of the fee application were prepared after the case ended, not contemporaneously. The time entries were also riddled with errors and mistakes.”

The simple point is not simply that keeping accurate, detailed and timely time records is not simply the gold standard, it remains the only standard.  Yes, virtually every lawyer abhors the notion of justifying his or her daily existence in twelve minute increments, and, yes, we all now know we sell valuable services not hours, time accurate, detailed and timely record keeping still remains with us.

But, there is more.

We have also recently learned essential the need to engage in project management, particularly in AFA engagements. Project management requires maintain GANT, PERT or similar charts, identifying critical paths and projections of the time necessary for each player to reach each critical path. Each player must also provide estimates as to when he or she will reach each critical path. No project manager can effectively carry out his or her responsibilities without tracking  in real time the time expended by each player. And at  the end of the day, in order to measure the profitability of the project and the efficiency of each player, an analysis of the time expended is a vital, indeed, essential tool. Lessons learned in the required post mortem of every completed project leads to more informed decisions on future pricing. Indeed, many RFP’s require law firms to describe their project management programs.  Some clients also require that the project management software be available to the client on an extranet.

Time management is also an essential tool for risk management.  In a recently well publicized case, a counsel at a large law firm was arrested for allegedly defalcating with many millions of dollars of client escrow funds.  While all of the facts are not in, it appears that the alleged perpetrator was handling work for some regular firm clients, not recording their time and privately charging the clients for his work.  These moonlighting activities ultimately apparently required the alleged perpetrator to deposit funds in an escrow account.  Since the matter was not recorded on the firm’s records, the young lawyer apparently went across the street and opened an escrow account in the firm’s name and he was the sole signatory.  The funds in this escrow account seem to have disappeared, with the law firm being the subject of claims for the funds as well as a failure to adequately supervise the alleged miscreant. It may well be that if this lawyer’s time charges were more carefully monitored, the entire problem may well have been avoided.

While you cannot always foil a determined and clever thief, requiring lawyers to account for all of their time, including non-billable time does serve as a deterrent.  Yes, banks with security cameras and guards stationed on the banking floor do get robbed.  But, some number of thefts are deterred.

Finally, I have long advocated that finders, minders and grinders all need to be equitably compensated.  In this more perfect world, lawyers who make contributions to the firm by entertaining clients, blogging, attending conferences, speaking at seminars, writing important articles, as well as those lawyers who toil away at pure client services or engage in the thankless task of managing the enterprise, are entitled to compensation for their efforts.  These efforts shouldn’t be simply recalled anecdotally, but recorded on a timely basis.

So you’re still incredibly annoyed about recording your time in twelve minutes increments, I am afraid  you’re just going to keep sucking it up. You’re probably equally annoyed about developing creative methods of pain and pleasure to assure timely compliance with time keeping requirements, but that annoyance is not quite going away either.

As they say, there’s an app for that:  A wide variety of timekeeping programs allow a timekeeper to toggle on and off at his or her computer time working on client matters.  And for the road warrior, there are IPad, IPhone and Android apps that you can also toggle on or off and the information is downloaded to your mainframe or your cloud.

The Law Firm of the Twenty-first Century isn’t your granddaddy’s law firm. But it still requires detailed, accurate and timely time keeping of all of your activities.

© Jerome Kowalski, December, 2011.  All Rights Reserved.

 Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at jkowalski@kowalskiassociates.com

Much Ado About Nothing: The ABA’s Ideas About Admitting Nonlawyers to Law Firm Partnerships; “Alternative Law Practice Structures”


The Washington D.C. office of the American Bar...

Image via Wikipedia

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             December, 2011

The American Bar Association’s Commission on Ethics 20/20 just released its long awaited “Discussion Paper on Alternative Law Practice Structures.”  The report immediately brought to mind  Judge Posner’s recent decision in which he bench slapped a lawyer in a written and illustrated opinion by comparing him to an ostrich for ignoring an obvious case which the court felt controlled in the matter sub judice. My take is that the Commission simply ignored facts already on the ground and, more significantly, completely sidestepped the more urgent question, namely whether the United States would follow the lead of the United Kingdom and permit non lawyer ownership and equity investments in law firms. Our cousins across the pond call this model “Alternative Business Structures” or sometimes the “Tesco” model (the latter based on the ubiquitous retailer of that name).

The essence of the Commission’s report, predicated on the notion that lawyers in the United States some current ethical strictures relaxed so that they can effectively compete on the global stage, mandate the following changes which would permit nonlawyers to hold equity in a law firm, subject to the following strictures:

 such law firms would be restricted to providing legal services;

 nonlawyer owners would have to be active in the firm, providing services that support the delivery of legal services by the lawyers (i.e., the firm cannot be a multidisciplinary practice);

 nonlawyer ownership and voting interests would be restricted by a percentage cap sufficient to ensure that lawyers retain control of the firm;

 nonlawyer owners would be required to agree in writing to conduct themselves in a manner consistent with the Rules of Professional Conduct for lawyers; and

 lawyer owners would be responsible for both ensuring that the nonlawyer owners in their firm were of good character and supervising the nonlawyers in regard to compliance with the Rules of Professional Conduct.

These recommendations are, frankly, superfluous and add nothing to the current marketplace. . More significantly, market forces and realities have already pushed the envelope way beyond the Commission’s shortsighted vision.

For example, the Commission noted that many proponents argued that in order to attract the highest quality management and support staff that today’s legal market demands, law firms should have the opportunity to provide these personnel with an equity kicker. But, the fact is that the market long successfully dealt with this issue by simply paying top quality nonlawyer support personnel partner level compensation and bonuses. Famed comedian Jackie Mason does a great riff on how some people just want to be called partners for bragging rights, but the fact is that as Jerry McGuire said, “just show me the money.” And as we well know, law firm partners are nothing more or less than employees at will.

Second, the purported extant strictures limiting the services a law firm can offer to the delivery of legal services have long been ignored and circumvented through the creation of law firm subsidiaries that offer a plethora of services, some not even law related.

Moreover, substantial nonlawyer control currently exists in that many law firms are rather tightly controlled by their lenders.  It is often said that Citibank owns more law firms in the world than anybody. And banks can exercise the ultimate control:  they can force a law firm to shut its doors.

The final piece of what is to me plain silliness are the peculiar requirements that nonlawyer partners need to be vetted to be assured that they have the character and fitness required for bar admission and their conduct must be monitored by lawyer partners to assure that they are in full compliance with the Rules of Professional Responsibility.  Who is going to do this vetting?  And should a nonlawyer partner violate one of the Rules, who is going to be subject to discipline?  As I said before, top notch professionals just want to be “shown the money” and treated with professionalism and respect.  Having a business card that contains the word “partner” is no assurance of financial reward, job security or being treated with respect or dignity.

The tonier topic, is of course private equity investment in law firms.  As for that issue, the Commission blithely said

The Commission has ruled out certain forms of nonlawyer ownership that currently exist in other countries. In particular, the Commission rejected: (a) publicly traded law firms, (b) passive, outside nonlawyer investment or ownership in law firms, and (c) multidisciplinary practices (i.e., law firms that offer both legal and non-legal services separately in a single entity).

But whether you are a believer or a doubter concerning the Alternative Business Structures, it is a topic that demands immediate attention and public debate.  But as with so much else that Commissions do, it simply kicked the can down the road and agreed to continue to study the issue.

As that can goes rolling down the road beyond any visible horizon, the United Kingdom, hell  bent  on being the home base to the world’s great law firms, will take robust advantage of its substantial head start, legal services will be increasingly be provided by nonlawyer owned and unregulated Internet providers of legal services and  offshore LPO’s will continue to take larger market share, again in an environment where they are not owned by lawyers, not regulated and often under insured.

My expectation is that the next step in the evolution of  law firms will largely continue to evolve and form significant joint ventures with non-traditional providers of legal services.

In one of the next belated iterations of the Commission’s discussion papers, the Commission and the bar will arise from its long slumber and look around at a brand new world and perhaps even wonder “how did all of this happen; who was asleep at the switch?”

© Jerome Kowalski, December, 2011.  All Rights Reserved.

 

Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at jkowalski@kowalskiassociates.com


The End of Alternative Fee Arrangements?


Cover of "The End of Lawyers?: Rethinking...

Cover via Amazon

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             November, 2011

In doing my nightly reading last evening in order to keep up with the latest trends in the legal profession, I came across a very recent brief video clip from Richard Susskind that made me bolt upright and reach for a very stiff drink.  The clip is a bit nerve rattling; accordingly, as they say, viewer discretion is advised.

The headline on the clip is certainly designed to grab your attention:  It has Sir Richard purportedly suggesting “The End of Alternative Fee Arrangements?” Quite obviously, this headline grabber is a clever play on Sir Richard’s seminal work “The End of Lawyers?”  My first thought was whether all of my work on AFA’s over the past few years was for naught. Or was it like the chimera of the tooth fairy, the Easter bunny or Santa?

In fact, on my second and third view, Sir Richard’s admonition became far more lucid and perhaps obvious:  2012 will be the last year in which the need to meet the demand for a reduction of the legal spend will be met almost exclusively by resorting to AFA’s.

Much more of Sir Richard’s observations are both chilling and enlightening:

  • Contrary to general opinion, the legal spend in the coming year will be reduced by 30 to 40%.
  • General counsel and law firms are going to need to meet these demands by creating yet new efficiencies.
  • Lawyers will need to meet demands for more legal services and receive less remuneration.
  • General counsel and law firms will need to learn work far more collaboratively.

Serendipitously, this morning my friends at Altman Weil, released their Annual Chief Legal Officer Survey.  Altman Weil’s take is consistent with much of Sir Richard’s admonitions in that in spending money for legal services, “Efficiency Trumps Costs.”

However, Altman Weil’s survey numbers are a bit less glum than Sir Richard’s prognostications:

  • “Fifty-six percent of CLOs said they had increased their internal budgets from 2010 to 2011, compared to 51 percent the previous year. The median increase also ticked up from 6 percent to 7. Forty-six percent of respondents increased outside counsel expenditures, up from 43 percent a year earlier.”
  • The median budget for outside counsel increased by 10%.
  • Controlling costs topped CLO’s list of priorities.
  • 13% of CLO’s outsourced work, previously performed by traditional law firms,  to non-traditional vendors of legal services.
  • 60% of CLO’s promoted collaboration rather than competition from their outside law firms.
  • For the third year in a row, top lawyers said they don’t think law firms are serious about changing their service delivery model. They gave firms a median rating of three, on a scale of zero to 10. But the companies aren’t doing much better. Respondents gave themselves a five in terms of how much pressure they were putting on firms to improve the value proposition.
  • 35 percent of respondents said they regularly and formally evaluated outside counsel, and only 17 percent said they communicated evaluation findings to the firm.

On this last and perhaps most significant point, Dan DiLucchio of Altman Weil had a most telling observation: “As long as the company is sending them work,” says DiLucchio, “the firms assume that that is their evaluation.”  Law departments miss out on the opportunity to change the firms’ behavior, says DiLucchio. He’s seen one of two things happen for firms: “Either you die a slow death, where the faucet is slowly turned off. Or you’re just called in one day and told that the company is moving the work elsewhere.”

These slow deaths and sudden terminations are completely preventable. But it is the obligation of outside counsel to be extremely pro-active in doing so. The steps we encourage our law firm clients to take are very straightforward:

  • Build an extranet.  Make all of your work for the client, not merely timekeeping, completely transparent. Clients should be able to click on their files and have full access to the work done and in progress.  Clients should be encouraged to actively engage the extranet and provide their input. Never respond to a client’s compliant about work done or budget overruns by blithely saying “gee, it was all on the extranet, you should have known.”  The extranet does not absolve the lawyer from communicating to the client.
  • Every monthly bill rendered should be accompanied by a letter that describes the objectives the firm had set out for the preceding month for the matter, the steps the firm had taken to meet those objectives, the results and the objectives for the next month. Even where the matter is undertaken on a fixed fee or an AFA, these monthly letters are essential.
  • In mid-month, send the client a time run of time spent on the matter. Let the client know it is for informational purposes only.
  • When an event occurs in a matter that materially affects either the fee or time budget, get on the phone and let the client know at once.  Explain the issue in detail. Let the client know how you propose to deal with this hiccup and solicit the client’s advice on the proposed course of action.
  • Take a page out of the book of Ed Koch,  New York’s long term mayor, who always greeted voters and visitors with “How am I doing?”  annual client surveys, annual visits by a managing or originating partner just don’t do the trick anymore.  You have to be on the telephone with regularity communicating with the client.  You must visit the client with greater regularity.  Your visit should be carefully planned out, as explained in detail here.

Yes, this is a lot of work.  But it is far less painful than seeing your revenues fall by 30%, watching the faucet slow to a drip or being told where to send all of the client’s files.

© Jerome Kowalski, November, 2011.  All Rights Reserved.

 

Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at jkowalski@kowalskiassociates.com .

Citibank’s Third Quarter 2011 Report on Law Firm Profitability: The Good News is That Cash Collections Were Up for the Quarter; The Bad News is There is a Lot More Tunnel at the End of the Tunnel


North East from 30 Rock (Including CitiGroup)

North East from 30 Rock (Including CitiGroup) (Photo credit: TGIGreeny)

 

                                                                             Jerome Kowalski

                                                                             Kowalski & Associates

                                                                             November, 2011

 

As law firm expenses continue to rise more quickly than revenues, law firms are looking at a real hole in their buckets

Like so many of us, I so admire and respect Citibank and the leader of its law firm lending group, ably headed by Dan DiPietro.  I not only look forward to Citi’s quarterly reports on law firm profitability, but as so many of us do, I carefully parse through Citi’s reports, since even when Citi informs us that storm clouds are about and more are to come, it somehow manages to give the impression that the climate is balmy and sunny days are ahead.

In this regard, Citi’s report for the  third quarter of 2011 does not disappoint. Not that Citi reports much good news nor does it predict coming good times; but, as always, Citi, the master of euphemism, posts some important warnings in terms that seem to provide some comfort. But, the fact remains that, after performing some exegesis of Citi’s most recent report, it is clear that Citi is telling us that current law firm economics are not very rosy and the coming months are foreboding.

Citi, which serves some 600 law firms and 58,000 lawyers in the United States and the United Kingdom, likes to lead with the good news and here it is: Cash collections for the third quarter were strong,  The bad news:  Demand for legal services continues to decline, marking the fourth quarter of consecutive decline in demand for legal services, while during the same period, expenses continued to rise,  consistent with Citi’s last report.

Says Citi:

 Cumulative growth in demand for the first nine months was 1.5 percent, down from 1.8 percent during the first six months. This indicates that growth in demand slowed to only 0.9 percent for the third quarter. This is likely a result of the slowdown in transactional work caused by the market shake-up. The slowdown has hit Am Law 50 firms (the 50 highest-grossing firms on The Am Law 100) particularly hard.

Citi went on to note that rate increases remained steady at 3.7% and realizations were strong.  But a moment later, it also cautioned as follows:

 Expenses, which had already risen by 4.7 percent during the first half of 2011, continued to gain momentum during the third quarter, as they have now increased 5 percent across the industry for the first nine months of this year. This was driven by a continued increase in operating expenses—and in compensation expenses, since we saw a slight uptick in head count during the third quarter, likely due to the entry of first-year associates.

Quite obviously, where your rates are increasing by 3.7% and your expenses increasing by 5%, you are slowly losing ground. Citi acknowledged as much:

This modest increase in associate head count, combined with the slowdown in demand in the third quarter, translated into a decline in productivity gains—from 1.6 percent growth for the first six months of 2011 to 0.9 percent growth for the first nine months.

Tucked away in the middle of a following portion of its report is the most disturbing news of all in the current report, dealing with the very troubling decline in demand for future legal services and continued decline in WIP:  Citi’s report on WIP showed that WIP is currently at

 3.6 percent for the first nine months (versus a cumulative growth rate of 6.3 percent for the first six months). The last time we saw the third-quarter inventory growth rate slowing from the first-half rate was in 2008.  [Emphasis Added].

Citi went on to report on the winnowing down of equity partner ranks at law firms, while increasing activity in lateral hiring. Lateral partner hiring is certainly a positive sign; it signals optimism by law firm leadership and the willingness to fill in valleys of revenue decline by bringing in new partners with loyal client followings. But robust lateral partner recruiting is far from a panacea.  Every lateral partner comes at a real cost, consisting of recruiting fees, where applicable, and the investment in “ramp up.”  For the uninitiated, ramp up consists of that period of time which commences when the lateral partner and his professional and support staff join the firm and are fully compensated until the time that their efforts result in revenue to the law firm, a period typically lasting approximately ninety days.  Thus, while successful laterals do contribute to WIP, they do add materially to the expense side, which some firms have attempted to treat as capital costs. But in simple cash accounting, laterals cost money and mitigate equity partner profitability.

The reader must be mindful that Citibank’s survey is skewed in that it is largely based on AmLaw 100 firms – “44 Am Law 1–50 firms, 36 Am Law 51–100 firms, 49 Second Hundred firms, and 54 additional firms.”  Those firms at the top of this food chain are largely hiring laterals by showering them with gold, not always a great idea..  Firms on the lower end of the food chain are faring much better, in our own experience.  We are seeing many mid-size firms picking up quite a number of attractive top tier law firm partners, who are being squeezed out of AmLaw100 firms simply because their client bases, often quite substantial just won’t swallow the $1,000 hourly rate level required by the top tier to feed its expense levels.  The fourth quarter of every tear is the season of redemption for many, as lateral candidates anxiously scour the market scooping up offers that they will formally accept as soon as the spoils of the previous year are distributed.  Mid-size law firms – the “additional firms” in Citibank’s report – have actually done remarkably well these past two years and they are scooping up many of the soon to be AmLaw 100 refugees at record rates.

The continuing decline in the leverage model and decreased work available for firm lawyers also did not escape Citi’s attention:

 We have recently begun highlighting in our roundtables the rising cost of leverage for law firms. Looking at the 100 most profitable firms from 2001–2010 in our database, we saw a discernable decline in the percentage of associates represented in the leverage composition and a significant growth in the income partner, counsel, and of counsel categories. The result is a much more expensive leverage model, which would be fine if these more expensive lawyers were as productive as equity partners and associates, but they are not. In looking at average annual lawyer productivity from 2001 to 2010, income partners and counsel worked about 150 hours less than equity partners and associates.

“Much more expensive leverage models” is simply a euphemism for the fact that the Cravath system continues to disappear and service partners and counsel as important profit centers are similarly withering.  In other words, the old pyramid model hasn’t really disappeared; it has just been turned completely upside down.

There was also rising concern at Citi concerning the continued growth of Alternative Fee Arrangements and lowered reliance on billable hours, which Citi is concerned might result declining law firm profitability. As I have discussed in the past, AFA’s can actually enhance profitability, if properly managed, and current economic climes, with both declining demand for legal services and increased competition for those legal services require law firms to be more agile and develop new, more efficient and more profitable models for the delivery of legal services.

Citibank, like everyone else, expects an exceptionally hard push for final quarter collections. After all, following a rather difficult year of rising expenses and weakening demand, the need to boast of high PPEP is largely contingent on an extraordinarily strong squeeze in coming weeks.  But as corporate clients have mightily increased their own cash management and stretched out account payable schedules, these efforts may very well be an irresistible force meeting an immovable object.  Something’s got to give.

My own advice is forget about boasting about your PPP; instead, make the far more important investment in enhancing the firm’s long term relationships with its clients.

© Jerome Kowalski, November, 2011.  All Rights Reserved.

 Jerry Kowalski, who provides consulting services to law firms, is also a dynamic (and often humorous) speaker on topics of interest to the profession and can be reached at jkowalski@kowalskiassociates.com

The Clock is Ticking: In Five Years, Traditional Law Firms May be Extinct. What Are You Doing to Avoid Being an Artifact?


English: Street clock in Globe, Arizona, USA F...

Image via Wikipedia

                                                                                                Jerome Kowalski

                                                                                                Kowalski & Associates

                                                                                                September, 2011

We recently warned that traditional law firms were in danger of being replaced by Internet based providers of legal services, unregulated entities not owned or even having lawyers perform the legal services. We also addressed the issue of unregulated LPO’s, similarly not owned by lawyers and often heavily populated by lawyers not even being educated at an American law school and certainly not being admitted to the bar in the United States.

On the heel of those reports, Paul Lippe, founder and CEO of www.legalonramp.com wrote a compelling piece in the ABA Journal entitled “The Rise of the Non-Firm Firms.”

Paul posits, quite correctly I would say, that entities that he calls “Non Firm Firms”  (“NFF’s”),  namely the group of vendors that compete with traditional law firms for providing legal  ervices, have five distinct advantages over law firms, with which traditional law firms (“TF”S”) cannot compete.

First, Paul notes that the “non firm firms” “do a few things and only those things: typically e-discovery, due diligence, contract review and management, research, and other high-volume  ctivities.”  They are pointedly not full service law firms.  They recognize, as Jeff Carr the voluble distinguished general counsel at FMC has long noted, that legal services can be into four buckets: counseling, advocacy, process and content. Paul goes on to note, “Counseling and advocacy work is the true province of lawyers and requires specialized expertise and judgment; process and content work is generally repetitive, information processing work. Because the process and content work has been “bundled” with the TF’s bread-and-butter advocacy and counseling work, it has been delivered and charged as if it were high-value work. But it’s not. So clients will start to unbundle some of the process and content work to the NFFs, and it is likely that large companies will pick one NFF to work with directly, and then tell all their TFs (or at least their TFs who haven’t figured out how to work with NFFs) to work with that designated NFF.”

Next, Paul notes that the NFF’s are designed from the ground up, engineered with a view towards providing efficient services, not hidebound by any pre-existing norms, giving them enormous pricing advantages. Their owners are investors who seek out a profit from their investment, not from their labors, as is the case in the TF. Paul goes on to note that since these NFF’s are the new kids on the block, they are far more receptive to feedback from their clients. Then, assuming that the market for legal services is a total of $50,000,000,000 annually, Paul estimates that the NFF’s will grab 10% of that market by 2016 (current reports suggest that NFF’s will gross $2.5 Billion by next year, up from $500 Million only two years ago).  Paul suggests that for every dollar the NFF’s grab, TF’s will lose between $1.50 and $2.00.

Paul’s solid advice to TF’s who want to survive is:

A. Do a rigorous inventory of your process and content Work. Don’t just sit around and persuade yourself that everything you do is advocacy and counseling: Do a force-ranking of your time from five largest recent matters and characterize at least 25 percent as process and 15 percent as content. Then look at that work and ask yourself the Jack Welch question: If you were starting a new business to do that better, faster and cheaper, how would you do it?

B. Study the methods of the NFFs. Go to websites for Integreon, Axiom and NovusLaw and others and really understand what they’re saying. Don’t dismiss it as “jargon” or “buzzwords.”  (What do you think nonlawyers think of words like indemnification or disclosure? All specialized language sounds jargony to the nonspecialist.)

C. Develop an alliance with an NFF. Pick one and do a project with that firm.

D. Ask your clients for systematic feedback, and discuss with them how to do process work more efficiently.

Adding to this discourse, the eminent Sir Richard Susskind just announced that there is a five year expiration stamp on traditional law firms.  Sir Richard said that by 2016, both law firms and corporate general counsel  “will embrace legal process outsourcing, off-shoring, de-lawyering and agency lawyers.”   Susskind observed, “the endgame will not be about labour [he is British, you know] arbitrage: ‘I predict that the third phase, from 2016 onwards, will involve great uptake of information technology across the profession, such as automated production of documents and intelligent e-discovery systems – these are applications that will be staggeringly less costly than even the lowest-paid lawyers.”

There is truly not much air that separates Lippe’s and Susskind’s prognostications, views and recommendations.

Professor Susskind highlighted four main strategies GCs could embrace – driving down law firms’ prices, reshaping the in-house department, combining the two, or starting with a blank sheet of paper and undertaking a comprehensive legal needs analysis for the business. “Once these requirements have been identified, the task then is, dispassionately, to identify how best to resource the full set of needs, drawing not just on conventional lawyers but on the new legal providers too.”

Describing this last option as the most ambitious, he said it will “deliver the most cost-effective and responsive legal services for large businesses in the future”. It ties in with his vision of “legal process analysis” and multi-sourcing, where the legal requirements of an individual matter or a whole business are analysed to determine the most efficient way of sourcing each element of it.”

And that, as Sir Richard previously observed will be the end of traditional  law firms.

Few have the ability to start with the blank piece of paper and focus on “faster, better, cheaper,”  a daunting challenge for traditional law firms. Some, such as www.Clearspire.com and www.rimonlaw.com   have started on that path and their models seem to be gaining impressive traction.

The point is that the clock is ticking. It took over a century for the traditional law firm to evolve. Susskind and Lippe are warning us that we are five years away from extinction.

What will you be doing to avoid being the T-Rex in the museum display case?

© Jerome Kowalski, September, 2011.  All rights reserved.

%d bloggers like this: